Yahoo's Panama Pleases Investors

The long-awaited upgrade to the portal's search-ad ranking system will launch on Feb. 5. The Street cheered the announcement—but will it be enough?

by Robert Hof

After struggling for more than a year to catch fast-growing Web giants such as Google and MySpace (NWS), Yahoo! isn't out of the woods yet. But it may finally be seeing some sunlight through the thicket.

On Jan. 23, the Internet portal reported fourth-quarter profit that handily outpaced expectations as sales rose 13%, to $1.7 billion. Profit fell 61%, to $269 million, from a year ago, when Yahoo logged a gain on the sale of a China operation, but the 19¢-a-share profit easily beat analysts' 13¢ prediction. Initially, that wasn't enough to thrill investors, who swiftly knocked the stock down about 2% in extended trading, thanks to a muted forecast for a 14% rise in sales this year.

Momentum

But as soon as Chief Executive Terry Semel mentioned that a long-awaited improvement to Yahoo's search-ad system, known as Project Panama, would roll out earlier than expected, the stock reversed course and shot up more than 5%. The rally reflected the relief of investors who already were betting the worst could be over for Yahoo (YHOO) and were watching for any sign to the contrary. Shares have risen 7% since the start of the year and have been up as much as 10% this month. That follows a 35% swoon last year.

Panama, originally scheduled to launch last year, is Yahoo's attempt to close a sales gap with Google (GOOG). Yahoo's search ads produce far less revenue for advertisers because the company's formula for running ads is based solely on how much advertisers bid on search keywords—the words that trigger the placement of an ad alongside search results. By contrast, Google takes into account how many people click on those ads, so they end up being more relevant to searchers—and elicit two or three times as many clicks as ads on Yahoo.

For the past two years, Yahoo has tried to improve the performance but has run into delays getting Panama out the door. Now, the new platform goes live in the U.S. starting Feb. 5, followed by international markets, starting with Japan in the second quarter. Yahoo wouldn't say how much it expects Panama to improve search revenue besides promising that it would see a "double-digit" increase in revenue per search in the second half. "We expect to see revenue impact to begin in the second quarter and gain momentum throughout 2007," Semel said in a conference call with analysts.

"Transition"

Already, advertisers are champing at the bit. Despite Google's dominance in search ads—or perhaps because of it—companies crave an alternative so they're not overly dependent on Google. Despite some advertisers' difficulty learning the new system, early reviews of Panama from advertisers and agencies are positive, with many saying the system is easier and faster to use than Yahoo's current system. "We're definitely hoping it will help even the playing field," says Adam Kasper, senior vice-president and director of digital media for MediaContacts, a digital ad agency.

Panama is not the only upside opportunity in the coming year. Yahoo's deal to sell ads on eBay (EBAY), its agreement with a newspaper consortium to run job ads online, and a partnership with ad network Right Media to sell space on less-trafficked Yahoo pages all could kick in this year. "There's some real tangible business catalysts," says Rob Sanderson of American Technology Research, who has a buy on the stock.

Even so, Yahoo is far from home free. Semel himself tacitly acknowledged as much by using the word "transition" to describe Yahoo's likely performance this year. That's usually a code word for a tough year, but it also may be an attempt to manage expectations at a time when Google's momentum shows little sign of slowing and Yahoo faces challenges on a number of fronts.